In recent years, more than one hundred Chinese companies have adopted the VIE structure for their offshore listings, including internet companies such as Alibaba, Tencent, Baidu, Sina, Tudou, etc. That is beginning to change, because while the PRC authorities still welcome foreign investment, they have begun to be more concerned about "hot" money flowing into China through less than above-board means. h�bbd``b`�$����@�-H0��$ڀ�!$X��X � ĕ)i, �J@B�����r u L�@B�HT�d`bd�� �3�}0 �� F endstream endobj startxref 0 %%EOF 421 0 obj <>stream A variable interest entity (VIE) refers to a legal business structure in which an investor has a controlling interest despite not having a majority of voting rights. Once the persons who control the domestic companies may get reasonable or greater returns from the offshore companies, the risk on severing the VIE structure by them will be reduced accordingly. To better maintain the stability of the VIE structure, the following options may be adopted: (i) Diversify the shareholding of the domestic company. To achieve the initial public offering ("IPO"), there are two options for Chinese companies, onshore listing (also known as A-share listing) and offshore listing (also known as red-chip listing). The result is typically difficult, expensive and time-consuming dispute resolution process, which may lead to some kind of settlement or, alternatively, the foreign investor giving up on the PRC domestic company and their presence in China. China blinks on PCAOB; Kennedy Bill and MNCs; Sidebar. The perfect arrangement would be that each shareholder alone or in conjunction with other related shareholders holds less than 33% equity interests of the domestic company. For the red-chip listing, there are two commonly-used structures for Chinese companies: the straight-forward offshore listing structure and the VIE structure. With respect to the encouraged and permitted industries, there are few restrictions on foreign investment, which means that foreign investors may usually make investments freely in those industries. The cash flow goes like this:  SPV1 will fund the SPV2. Related Content. If no shareholder alone or in conjunction with other shareholders, over whom he/she may bring influences, may control the domestic company, at least, it may help to reduce the risk of losing control of the domestic company. Known as variable interest entities (VIEs), these entities have complex corporate structures that non-China investors have used to own Chinese companies listed overseas. However, after several years’ development, the asset-heavy companies also began to choose VIE structures for their financing or offshore listing and the typical example was China Qinfa Group Limited. 13 March 2019. In fact, it is unimaginable and unreasonable that such asset-heavy companies may move enormous assets out of China only by several agreements without any governmental approval or other legal procedures. 386 0 obj <> endobj 408 0 obj <>/Filter/FlateDecode/ID[<34BD02C8B48A844DB678965F68EBE51F><5427FD1F7EB542D584CCAF0CD0880C92>]/Index[386 36]/Info 385 0 R/Length 103/Prev 309145/Root 387 0 R/Size 422/Type/XRef/W[1 2 1]>>stream Sina might have chosen to use the VIE structure in 2000, to some extent, because it obtained the tacit consent from the PRC authorities. L. 195 (2012-2013) Variable Interest Entity Structures in the People's Republic of China: Is Uncertainty for Foreign Investors Part of China's Economic Development Plan On the other hand, we tend to pay little attention to such failed cases in which the domestic foreign investors even lost control over the domestic companies. Awards. Article 9 of the Rules re-attracts concerns from the public, which provides that with respect to merger and acquisition ("M&A") of the domestic enterprise by foreign investors, whether the M&A transaction falls within the scope of national security review shall be judged from the substantive contents and actual influences of the transaction; and foreign investors shall not avoid national security review through any means, including without limitation commissioned shareholdings, trusts, multi-level investments, leases, loans, contractual control, overseas transactions, etc. As a result, securities lawyers have designed corporate structures using variable interest entities (VIEs) that serve two fundamentally inconsistent functions: (1) satisfying Chinese regulators that the ownership and actual control resides with Chinese nationals while (2) convincing foreign investors that they have ownership and control rights. Most Influential People in Accounting. By Jonathan Barnett July 28, 2020 by renholding. h��W�r9���=BmA뮙**U�!��,����J�@�6.Y�[}�����. The Circular on Strengthening the Administration of Foreign Investment in Value-added Telecommunications Services ("Circular") promulgated by the Ministry of Industry and Information Technology ("MIIT") on 13 July 2006 was the first attempt to explicitly circumscribe the use of the VIE structure. The PRC authorities may also be on the alert for the abuse of VIE structure in asset-heavy industries. We open doors to global clients and unlock opportunities for them as they look to unleash the fullest potential of the Asian Century. by Practical Law China. The VIE structure is also commonly referred to as the Sina-model structure, since it was first used by Sina in 2000. Moreover, even if the contractual arrangements are finally enforced under PRC law, the damages to the company will be significant for the investors. In the Circular, it is provided that a telecommunications enterprise within the territory of China may not lease, shift or sell any license for telecommunications business in any form, or provide resources, places and facilities or any other conditions for any foreign investor to engage in any illegal telecommunications operation by any means within the territory of China. Most investors prefer not to deal with regulatory risk. As a general rule, the PRC authorities typically do not like the idea of foreign investors using indirect ways to get around legal restrictions on foreign investment in the first place; however, in order to attract foreign investment in technology focused industries such as telecommunications and internet, the PRC authorities have tended to acquiesce the usage of the VIE structure in China. In addition the VIE structure has also been used as a means by which Chinese domestic entities could list offshore on international capital markets. 1 Investors in Chinese companies soon encounter an obscure accounting term –the variable interest entity or VIE. As a result, the scale has tipped from welcoming foreign investment to higher scrutiny of the legality of the transaction structure. National Development and Reform Commission, State Administration for Industry & Commerce, Variable Interest Entity Structure in China, Sino-Korea Cooperation in Culture and Entertainment, Investing in Republic of Korea: Establishing a Local Entity. From the regulatory perspective, the Circular and Online Games Notice are both only regulations other than laws; however, such regulations at least send a signal on use of the VIE structure. Sitemap includes index to all articles. In addition, investment into such pre-existing VIE structures on an offshore level might not attract the attention or objection from the PRC authorities. The variable interest entity (" VIE ") has long been a popular structure for foreign parties to invest in sectors which are restricted by China’s industrial policy to foreign investment. As a result, such former founder in fact still controls the domestic company. ; media companies such as Focus Media, Vision China Meida and Bona, etc. According to the Provisions on Guiding the Orientation of Foreign Investment, promulgated in 2002, and the Foreign Investment Industrial Guidance Catalogue revised in 2007, we understand that the industries are classified into four categories, namely, the encouraged, permitted, restricted and prohibited. Through a set of contractual arrangements among the WFOE, PRC individuals (usually PRC individuals are the companies’ founders) and the domestic company, the WFOE may be able to actually control the domestic company as if it directly owned the equity interests in such domestic company. By admin On October 7, 2019 ★ ★ ★ ★ ★ Variable Interest Entity Structure In China | China Law Insight inside Entity Structure Diagram, 5 / 5 ( 1 votes ) Download Full Image. Although the adverse effect was successfully eliminated and the VIE structure was retained at last, the instability from the structure is still a high profile case in the VIE’s history. China law, business and economics commentary . Variable interest entity, or VIE, structured companies have existed in China for more than 20 years and have spurred endless discussion on VIE-related issues. Another case is Agria Corporation, a Chinese seed producer which completed its IPO on NASDAQ in 2007, and which also faced the risk of losing control of the domestic company and such risk was eventually settled through compensation in equity and cash to the founder of domestic company (he was also the former director and the legal representative of the domestic company) who claimed the ownership of the offshore parent company. In addition, through the contractual arrangements between the WFOE and the PRC domestic company, the domestic company will also make certain payments to the WFOE for provision of services. However, during the five (5) years after the promulgation of the M&A Rules, there is no case where the approval was successfully obtained. In the early stage, the VIE structure was almost only used on the asset-light companies. Posted in Foreign investment. Once there are changes to such positions involving interests, potential risks of the VIE structure will appear. Above all, no matter from the legislation perspective or on a practical level, it is clear that the VIE structure faces the risks of uncertainty on policies from the PRC authorities. Sina and Agria Corporation both faced the risk of losing VIE structure, but fortunately, after hard negotiation, such risk was successfully removed and the VIE structure was retained eventually. To do this, it used a standard legal shuffle to deploy a variable interest entity, meaning it will transfer profits to an offshore corporation with shares that foreign investors can own. This payment will be part of the dividend to be distributed by the WFOE offshore, thus completing the chain of cash flow. On April 2, China’s Luckin Coffee announced that some of its employees, including the chief operating officer, had fabricated over $300 million in reported revenues. Leveraging our exceptional legal expertise and depth of knowledge in the China market, we advise Chinese and overseas clients on a full range of domestic and cross-border transactions, providing comprehensive legal services. However, due to restrictions on foreign investment, the WFOE cannot obtain licenses or approvals from the PRC authorities to operate in the desired industry. The VIE structure was set up between Alibaba Group and Alipay. The domestic company usually is the one which owns licenses or approvals for the business. The national security review process will apply only if the target domestic enterprise is involved in a business that concerns either national defense security issues ("National Defense Security Businesses") or national economic security issues ("National Economic Security Businesses"). (vi) the Loan Agreement entered into by and between the WFOE and PRC individuals, in which the WFOE extends a loan to PRC individuals to use for capitalization of the domestic company. (iii) Foreign investors establish foreign invested enterprises and purchase assets of domestic enterprises via agreements by such foreign invested enterprises and then operate these assets, or purchase equity interests of domestic enterprises by such foreign invested enterprises; and. ; (iv) the Call Option Agreement entered into by and among the WFOE, PRC individuals and the domestic company, in which PRC individuals grant the WFOE an option to purchase all or a portion of their equity interests in the domestic company at a lowest possible price permitted by PRC law; (v) the Equity Pledge Agreement entered into by and among the WFOE, PRC individuals and the domestic company, through which the PRC individuals pledge their equity interests in the domestic company to the WFOE as a guarantee of the performance of their and the domestic company’s obligations under other agreements among the three (3) parties in the VIE structure; and. When it comes to VIEs and related contracts, the distinction is important. For instance, if all parties to the contractual arrangements perform their obligations, everything is fine. Paul Gillis PhD CPA is Professor of Practice at Peking University's Guanghua School of Management. 2015 The Accountant Power 50. 13 Oct 2011 by Stan. In 2010, GigaMedia announced it was involved in the dispute with its former founder of the domestic company, who was removed from the domestic company but refused to return the company seal, financial chops and other documentation to GigaMedia. The promulgation of the Provisions for the Acquisition of Domestic Enterprises by Foreign Investors ("M&A Rules") on 8 August 2006 by six (6) PRC departments, provides that the domestic companies, enterprises or natural persons shall, when they merger and acquire related domestic companies through companies legally established or controlled by them in foreign countries, report to MOFCOM for approval and the persons concerned may not evade the above requirements by re-investment of the foreign-invested enterprises or by other means. (Rosier, 2014). As to those restricted industries, higher conditions or qualifications or stricter requirements are provided for foreign investors. Variable Interest Entity Structure in China. See more: http://prodygia.com/video_interviews/199-what-you-need-to-know-about-the-variable-interest-entity-vie-structure Renren and Baidu, for example, are variable interest entities. At the beginning, the VIE structure was used primarily for asset-light companies, such as internet companies, advertising companies, software companies, education companies and media companies, etc. They go … However, based on our experience, it is likely that previously established VIE structures may be left untouched. As the first firm in the world able to practice in China, China Hong Kong SAR, Australian, English, the US and a significant range of European laws, our presence and resources in the world’s most dynamic economies are profound. As a result, many investors began to re-examine the VIE structure. Variable interest entity (VIE) structures in China. The M&A Rules leaves a road for related M&A, i.e. The Notice on Further Strengthening of the Administration of Pre-examination and Approval of Online Games and the Examination and Approval of Imported Online Games  ("Online Games Notice") promulgated on 28 September 2009, provides that foreign investors are not permitted to invest in online games operating businesses in China via the WFOE, equity joint venture, or contractual joint venture, and it also expressly prohibits foreign investors from gaining control over or participating in domestic online games operators by indirect means, such as setting up other joint ventures, signing relevant agreements or providing technical supports. Furthermore, even though GigaMedia may regain the ownership and control of the domestic company, it is undeniable that such event will bring adverse effect on its business in China and its actual control of such domestic company. Considering the limited cases on national security review or other polices in practice, we would suggest that the companies should communicate with the PRC authorities first, obtain professional advice on a case by case basis, and then make a decision whether to utilize the VIE structure or how to use it properly. However, for foreign investors, the potential risks existing in the VIE structure and uncertainties in respect of government policies are just like the Sword of Damocles over their heads. This Circular also requires that the telecommunications enterprise which plans to list oversea shall first get the approval from MIIT. 21 Cardozo J. Int'l & Comp. Most of time, we only notice there have been more than one hundred Chinese companies which successfully achieved listing overseas. The Variable Interest Entity (VIE) structure has been accepted by foreign investors as a mode of investment in sectors that are restricted for foreign capital in China. In the listing process of Sina, when one Sina’s founder was removed from Sina, the VIE structure was affected by such change of senior officers or shareholders of domestic companies. 28 Sep 2011 by Stan. Instead, they will purchase shares in a Cayman Islands entity named Alibaba Group Holding Limited. (iv) Foreign investors directly purchase assets of domestic enterprises and establish foreign invested enterprises through such assets to operate such assets. Variable interest entity (VIE) Related Content. In respect of the risks from governmental polices, before establishing the VIE structure, the companies should ensure that the VIE structures are in compliance with PRC law and may be enforceable in the future. Meanwhile, certain key assets including trademarks, domain names and servers shall be held by the value-added telecommunications service provider or its shareholder which holds the value-added telecommunication service license. The typical VIE structure is set up as illustrated in the following diagram: As indicated in the diagram above, foreign investors and PRC individuals establish SPV1 in Cayman; then SPV1 sets up a wholly-owned SPV2 in Hong Kong; and then SPV2 establishes the wholly foreign-owned enterprise ("WFOE") in the PRC. From the above cases, it is not difficult to find that the VIE structure is not as stable as some have imagined, to say the least. In 2000, Sina Corporation made headlines by being the first Chinese business to list on the NASDAQ in New York using the 'Variable Interest Entity' ('VIE') structure, which uses contracts instead of shareholding to effect corporate control. To non-accountants, the VIE structure is a business structure that is widely used in certain business sectors in China that have prohibitions or restrictions on foreign investment under the 2019 … National Economic Security Businesses include enterprises involving major agricultural products, major natural resources and energy industries, important infrastructure projects, transportation services, key technologies, as well as major equipments that are related to national security. National Defense Security Businesses include military industry enterprises and supporting enterprises, enterprises adjacent to major and sensitive military facilities, and other entities relevant to the national security of China. SPV2 will make a capital contribution to the WFOE. The VIE structure helped over one hundred Chinese companies complete the offshore listings, but we should never forget such potential risks when we discuss the successful cases. Variable Interest Entities are a legal quagmire for investors to grapple with if they want exposure to the fast-growing internet enabled businesses in China. About the Editor. to obtain the approval from MOFCOM. However, if, for example, the PRC individuals or the domestic company decide not to perform their obligations under the contracts, the WFOE may have a difficult time to maintain control over the PRC domestic company. Of course, in those cases, Chinese companies avoided the restrictions on foreign investment and all relevant the PRC authorities’ approvals by using the VIE structures. In a securities filing in July, Alibaba Group disclosed that executive chairman Jack Ma will be stepping away from the company’s variable interest entities. To specify the implementation procedures of the national security review, later, on 4 March 2011, the Ministry of Commerce ("MOFCOM") promulgated the Interim Rules on Issues Related to the Implementation of the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors ( "Interim Rules"), which is replaced by the Rules on the Implementation of the Security Review System for Mergers and Acquisitions of Domestic Enterprises by Foreign Investors ( "Rules") on 1 September 2011. On the one hand, this case might simply reflect the local government’s attitude towards specific companies or industries, not towards the VIE structure itself. However, foreign investors should examine all facts and review all relevant laws and regulations before making a decision to create a new VIE structure in certain industries on a case by case basis. A VIE is an entity controlled by a company by means other than a majority of voting rights. This business structure, called a variable-interest entity, became common among Chinese companies because Beijing restricts foreign investment in certain sectors, such as the internet. Combining the Notice and Rules, we may conclude that the VIE structure has attracted increased attention from the PRC authorities, and such regulations only indicate that the PRC authorities have the intention to restrict the use of the VIE structure in certain industries. With respect to the risks from the structure, from the above analysis we may find that the certain persons in the domestic companies usually play a critical role in the VIE structure, and we all understand it is very important for the WFOE or offshore companies to avoid the risks from such persons. By King and Wood on February 9, 2012. ,H����n���X˰���5�wA�H�$�c��ڈ7-%br���)sv|���6�^q�s�o��'\��]�"Æ���Uǟ�ȱ?Sq~�Ƈg�-ׯ}s�����۷�T;&���9�C���ڦ�[�N��^����������H9��#���,���9@��h�>���b)pP�1�3Չ(�oPf�9��ɸ�{��d����Ǭ��Op�c)�i8}���U�_��DT��l��2�H320��i3�i�@���A�,�zHY3�l�(c 0 [��� endstream endobj 387 0 obj <>/Metadata 57 0 R/Outlines 83 0 R/PageLayout/OneColumn/Pages 382 0 R/StructTreeRoot 124 0 R/Type/Catalog>> endobj 388 0 obj <>/ExtGState<>/Font<>/XObject<>>>/Rotate 0/StructParents 0/Tabs/S/Type/Page>> endobj 389 0 obj <>stream The structure allows Chinese domestic entities to list on foreign capital markets. One is GigaMedia and the other is Alipay. twitter @profgillis. %PDF-1.5 %���� The WFOE will extend a loan to the PRC individuals, who will in turn establish and finance the PRC domestic company. gillis@gsm.pku.edu.cn. An entity where an investor has a controlling interest that is not based on holding the majority of voting rights. In addition, for the purpose of attracting foreign investors and for circumventing restrictions on foreign direct investment, during the Pre-IPO restructuring, the VIE structure is also widely used by Chinese companies and foreign companies alike. After obtaining supports from foreign funds or other foreign investors, Chinese internet companies got rapid and great development and some internet giants such as Baidu, Alibaba and Tencent, etc., have grown up in the last decade. Over past years, the PRC authorities never formally confirmed the validity of the VIE structure under PRC law. The "contractual control" mentioned in the Rules obviously refers to the VIE structure. Consequently, we have known some limited but significant cases in which the offshore holding companies lost control over the domestic companies. It’s very hard to model out such a risk, in seemingly binary outcomes. ; retail companies and companies in other industries. 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